Cot­ton Fu­tures – An Im­pact As­sess­ment Study

Dr. V. Shun­mugam Head - Re­search, Multi Com­mod­ity Ex­change of In­dia Ltd (MCX)

Dalal Street Investment Journal - - COMMUNICATION FEATURE -

Un­cer­tainty and volatil­ity in cot­ton prices re­main at el­e­vated lev­els. An­nu­alised volatil­ity of cot­ton prices were as high as 18.3% and 21.3% in 2016 and 2017, re­spec­tively. A part of the rea­son for such high volatil­ity is the in­ter­na­tional na­ture of this agri-com­mod­ity, whose 32 per cent of world pro­duc­tion en­ters in­ter­na­tional trade ev­ery year. This means that the fun­da­men­tal fac­tors in mul­ti­ple coun­tries, not to men­tion the dy­nam­ics of in­ter­na­tional trade, go on to de­ter­mine the prices of cot­ton in In­dia (as else­where). In fact, four coun­tries –

In­dia, China, United States and Pak­istan – ac­count for about 70 per cent of the world pro­duc­tion, which in­di­cates the ex­tent to which fac­tors orig­i­nat­ing in mul­ti­ple coun­tries af­fect cot­ton prices, or make them volatile.

When the height­ened volatil­ity in cot­ton prices is passed on to the value chain of the com­mod­ity – a com­plex maze run­ning from the farmer to the ul­ti­mate con­sumer, un­der­go­ing sev­eral lay­ers of pro­cess­ing and value ad­di­tion – the ef­fect is height­ened volatil­ity in the prices at each node of the value chain, giv­ing rise to in­fla­tion­ary ten­den­cies.

COT­TON DERIVA­TIVES AS A HEDGING TOOL

In or­der to cope up with this prob­lem, mar­ket-based risk man­age­ment tools have as­sumed sig­nif­i­cance in re­cent times. Com­mod­ity deriva­tives mar­kets serve as an im­por­tant plat­form for bring­ing sta­bil­ity in the com­mod­ity mar­kets by pro­vid­ing stake­hold­ers with the av­enue for risk man­age­ment. In the con­text of the cot­ton mar­ket, the ex­change-traded cot­ton fu­tures con­tract has been ben­e­fi­cial for all sec­tions of the econ­omy, in­clud­ing farm­ers and con­sumers; it pro­vides ad­vanced price sig­nals to sell­ers (farm­ers/pro­duc­ers) and as­sists buyers (con­sumers) of agri­cul­tural com­modi­ties to de­cide on the time for pur­chase of the com­mod­ity, giv­ing a tool for hedging the un­cer­tainty in prices across time pe­ri­ods.

Against this back­drop, a study# on the im­pact of cot­ton fu­tures was un­der­taken by the Icar-na­tional In­sti­tute of Agri­cul­tural Eco­nomics and Pol­icy Re­search, New Delhi (NIAP). The study, in­ter alia, in­ves­ti­gated im­prove­ments, if any, that cot­ton fu­tures might have brought on the stake­hold­ers of var­i­ous el­e­ments in the com­mod­ity’s value chain. It also ex­am­ined the in­di­rect im­pact of avail­abil­ity of fu­tures prices to the farm­ers and traders’ ecosys­tem through avail­abil­ity of knowl­edge about prices, price re­al­iza­tion by pro­duc­ers and price link­ages among the ma­jor do­mes­tic mar­kets and with the fu­tures mar­ket.

FIND­INGS OF THE STUDY

The main find­ings of the study are sum­marised be­low.

In­te­gra­tion of phys­i­cal and fu­tures prices : Price move­ments in fu­tures mar­kets were an­a­lysed with those in ten se­lected cot­ton mar­kets from five ma­jor cot­ton pro­duc­ing states of In­dia – M.P., Gu­jarat, Haryana, Te­len­gana and Ra­jasthan. The study found a great de­gree of in­te­gra­tion among the mar­kets and with the fu­tures mar­ket, with high, pos­i­tive and sta­tis­ti­cally sig­nif­i­cant co­ef­fi­cients of cor­re­la­tion among them. This in­di­cates that, leav­ing aside the lo­gis­tic cost of stor­age and trans­porta­tion, cot­ton prices across mar­kets move to­gether and are in tan­dem with the fu­tures prices. Higher in­te­gra­tion of cot­ton prices among the mar­kets also im­plies more com­pe­ti­tion among the mar­kets and hence farm­ers may ex­pect more com­pet­i­tive prices for their pro­duce. Since the signs of all the co­ef­fi­cients are pos­i­tive, prices were found to move in sim­i­lar di­rec­tion.

Price dis­cov­ery : The study re­vealed that cot­ton fu­tures has greatly helped the grow­ers with re­gard to pro­vid­ing some kind of re­fer­ral or in­dica­tive price at a ref­er­ence point to start ne­go­ti­a­tion with the buyer. Thus, even if the grow­ers were not trad­ing on the ex­change plat­form, they could de­rive a lot of ben­e­fit sim­ply by know­ing the ex­change-traded prices, and use that as a ref­er­ence for their ne­go­ti­a­tions. For in­stance, when en­quired about the over­all changes in the cot­ton in­dus­try after in­tro­duc­tion of cot­ton

Cot­ton fu­tures have had per­cep­ti­ble im­pact on the cot­ton ecosys­tem and var­i­ous stake­hold­ers, but much more re­mains to be achieved through wide­spread dis­sem­i­na­tion of ex­change-traded prices, ware­house re­ceipt fi­nance and prop­a­gat­ing the ben­e­fits of im­proved ef­fi­ciency, trans­parency and liq­uid­ity.

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